Dividends

Growing companies that pay dividends have performed well lately. In the Russell 1,000, there are about 300 stocks that pay no dividend. These non-dividend payers are down an average of about 7% since March. Conversely, the 300 highest yielding stocks in the Russell 1,000 are up an average of 3%.

A portfolio of stable, high-quality dividend payers now yields about 2.5%, in line with the U.S. 10-year Treasury. Stocks could, of course, quickly lose a couple years’ worth of yield in a market correction. Yet, as a rough gauge of investor preferences and relative value, dividend paying stocks are worth considering now for a lot of people. For the same yield, one can get either the safety of bonds or a portfolio of good-to-great companies that will likely pay and increase their dividends over time. Unless absolute safety is demanded, a dividend paying stock portfolio seems to have the advantage today.

A study by the French bank Société Générale found that dividend growth was the single-largest contributor to nominal returns across developed markets over the past 40 years, providing more return than changes in stock prices alone. Companies that can pay, sustain and grow their dividends tend to be healthier than those that cannot. During tough times, these types of companies can rely on the strength of their balance sheets and cash reserves to maintain positive cash flow and gain market share versus their competitors.

Dividends also have a tax advantage for most people. Dividends paid by corporations are taxed at a maximum 20% rate for federal income tax purposes if the position in the underlying stock has been held for more than sixty days. There are (not surprisingly) several fine points in the U.S. tax code regarding dividend income, but in general, taxpayers pay less taxes on their dividends than they do on much of their other income.

The performance of dividend paying stocks has begun to widen over the past several years, coinciding with baby boomers hitting retirement age. Retirees are beginning to focus more on the income generated by their portfolios, not the fluctuation in principal. Even in a typical bear market, the income generated by a dividend-focused portfolio will usually remain intact.

A dividend focused portfolio can still decline in value and dividends can be cut or eliminated. Blindly buying high yielding stocks of mediocre companies is a recipe for disaster. But ownership of a diversified portfolio of high quality companies paying dividends can make all the difference through good times and bad.